Godzilla banks must tread carefully

GODZILLA is being reborn in Tokyo's financial district. In fact, three Godzillas are about to start stomping about along with one that emerged last year. The monsters will be Japan's new Big Four banking corporations, which will officially burst on to the global financial scene on 2 April.

The equally big question is whether the four will hold the solution to Japan's appalling banking problems or be just another part of the apocalypse.

Some analysts fear that if one of the supergroups gets into financial problems then the impact on the rest will be magnified by the mergers.

The first of the mammoths emerged in September of last year when Dai-Ichi Kangyo Bank, Fuji Bank and the Industrial Bank of Japan, were rolled into the Mizuho Financial Group.

On Monday, Sakura Bank and Sumitomo Bank will merge to create Sumitomo Mitsui, Bank of Tokyo-Mitsubishi and Mitsubishi Trust & Banking will form Mitsubishi Tokyo Financial Group, and Sanwa Bank, Tokai Bank and Tokyo Trust & Banking will be combined to create United Financial of Japan.

Mizuho, with assets of US$1.3 trillion (£909bn) is already one of the world's titans, but Sumitomo Mitsui Banking, with $960bn, is not far behind, while Mitsubishi Tokyo Financial Group ranks third with $835bn, and even UFJ Group, with $820bn, can look the likes of Deutsche Bank in the eye.

Assets are one thing; quality of assets and the ability to make them work is something else, and this is where questions are being raised. Like every bank in Japan the Big Four are saddled with massive bad debts which the government is desperately trying to find acceptable ways of tackling.

The Bank of Japan has already raised concerns about the concentration of some of the worst areas of corporate delinquency into the hands of the new banks. The four will have almost 50% of the bad loans to the construction, real estate and non-banking financial sectors. None of these bombed-out sectors is showing any signs of improving as Japan's economy struggles at near-zero growth.

Adding to the festering loans has been the impact of this year's slide in Japanese share prices, which has eaten deep into the asset base of the whole Japanese banking system.

Thanks to decades of incestuous relationships with big corporate clients, the banks have huge cross-holdings of stocks whose prices have been decimated. In the past, this could be hidden, thanks to lax accounting standards which allowed the banks to include the holdings at cost. From the new Japanese financial year, which starts on 1 April, this fool's paradise comes to an end, and the portfolios will have to be marked in at current market prices from the September mid-year accounts.

According to varying estimates by analysts, when the Topix index of stocks reached 1200 last week, it left Japan's top 16 banks with unrealised losses of between $10bn and $33bn, and that is after trashing $620bn of bad loans over the past 10 years.

This still left them with at least $340bn in bad debts as at the end of last September, according to the Financial Services Agency, which is pressuring the banks to get the bad loans off their books, instead of juggling them through provisions that are rarely large enough.

The size of the problem was underlined earlier this month when the banks in the UFJ group said writing off bad loans would put them $1.8bn in the red in the year to end-March, a move welcomed as a healthy dose of reality.

While the FSA claims that Japan's banks are comfortably inside the 8% capital adequacy ratio set down for international banks, Tokyo analysts know that if the government subsidies and tax holidays were taken out, few would approach this figure.

Apart from the challenge of putting the balance sheets in order, the Big Four now face the practical problem of merging their businesses, integrating systems, and streamlining their networks. If that is going to mean workers on the street, it will be bad news for Japan's already deeply unpopular ruling Liberal Democrat Party.

These monsters are going to have to be careful where they put their feet.